Kingsway(KFS) - 2023 Q2 - Quarterly Report

PART I - FINANCIAL INFORMATION This section presents the unaudited consolidated financial statements of Kingsway Financial Services Inc. for the periods ended June 30, 2023, and December 31, 2022, including balance sheets, statements of operations, comprehensive (loss) income, shareholders' equity, and cash flows, along with detailed notes explaining accounting policies, significant transactions, and financial instrument valuations ITEM 1. FINANCIAL STATEMENTS This section presents the unaudited consolidated financial statements of Kingsway Financial Services Inc. for the periods ended June 30, 2023, and December 31, 2022, including balance sheets, statements of operations, comprehensive (loss) income, shareholders' equity, and cash flows, along with detailed notes explaining accounting policies, significant transactions, and financial instrument valuations Consolidated Balance Sheets The consolidated balance sheets provide a snapshot of the company's financial position at June 30, 2023, and December 31, 2022, highlighting changes in assets, liabilities, and equity Consolidated Balance Sheet Highlights (in thousands): | Metric | June 30, 2023 | December 31, 2022 | Change (2023 vs 2022) | | :-------------------------------- | :------------ | :---------------- | :-------------------- | | Total Assets | $195,344 | $285,650 | $(90,306) | | Total Liabilities | $173,424 | $263,529 | $(90,105) | | Total Shareholders' Equity | $21,920 | $16,108 | $5,812 | | Cash and cash equivalents | $14,162 | $64,168 | $(50,006) | | Subordinated debt, at fair value | $12,544 | $67,811 | $(55,267) | - Total Assets decreased by $90.3 million, primarily driven by a significant reduction in cash and cash equivalents and limited liability investments, at fair value[8] - Total Liabilities decreased by $90.1 million, largely due to a substantial reduction in subordinated debt following repurchases[8] - Total Shareholders' Equity increased by $5.8 million, mainly due to an increase in additional paid-in capital and a decrease in accumulated deficit, partially offset by a decrease in accumulated other comprehensive income[8] Consolidated Statements of Operations This statement details the company's revenues, expenses, and net income (loss) for the three and six months ended June 30, 2023 and 2022 Consolidated Statements of Operations Highlights (in thousands, except per share data): | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Total revenues | $26,197 | $23,590 | $52,586 | $46,046 | | Operating income | $393 | $1,528 | $1,281 | $770 | | Net (loss) income | $(1,667) | $(2,365) | $26,172 | $(4,869) | | Basic (loss) earnings per share - net (loss) income | $(0.06) | $(0.12) | $1.07 | $(0.24) | | Diluted (loss) earnings per share - net (loss) income | $(0.06) | $(0.12) | $0.98 | $(0.24) | - Total revenues increased by 11.0% for the three months and 14.2% for the six months ended June 30, 2023, compared to the same periods in 2022[11] - Net income significantly improved to $26.172 million for the six months ended June 30, 2023, from a net loss of $(4.869) million in the prior year, primarily driven by a $31.616 million gain on extinguishment of debt[11] - Basic and diluted EPS for the six months ended June 30, 2023, turned positive to $1.07 and $0.98, respectively, from losses in the prior year[11] Consolidated Statements of Comprehensive (Loss) Income This statement presents the net (loss) income and other comprehensive (loss) income, leading to total comprehensive (loss) income for the periods Consolidated Statements of Comprehensive (Loss) Income Highlights (in thousands): | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Net (loss) income | $(1,667) | $(2,365) | $26,172 | $(4,869) | | Other comprehensive (loss) income, net of taxes | $(674) | $5,401 | $(27,858) | $5,194 | | Comprehensive (loss) income | $(2,341) | $3,036 | $(1,686) | $325 | | Comprehensive (loss) income attributable to common shareholders | $(2,104) | $2,735 | $(1,461) | $(83) | - Other comprehensive (loss) income for the six months ended June 30, 2023, was a loss of $(27.858) million, a significant decrease from a gain of $5.194 million in the prior year, primarily due to reclassification adjustments for debt fair value changes[14] - Comprehensive (loss) income attributable to common shareholders for the six months ended June 30, 2023, was a loss of $(1.461) million, compared to a loss of $(0.083) million in the prior year[14] Consolidated Statements of Shareholders' Equity This statement details changes in the company's shareholders' equity, including common stock, additional paid-in capital, and accumulated deficit Shareholders' Equity Highlights (in thousands, except share data): | Metric | June 30, 2023 | December 31, 2022 | Change | | :------------------------------------------------ | :------------ | :---------------- | :------- | | Common Stock Shares Outstanding | 25,431,552 | 23,190,080 | 2,241,472 | | Additional Paid-in Capital | $371,118 | $359,985 | $11,133 | | Accumulated Deficit | $(344,025) | $(370,427) | $26,402 | | Accumulated Other Comprehensive (Loss) Income | $(1,258) | $26,605 | $(27,863) | | Total Shareholders' Equity | $21,920 | $16,108 | $5,812 | - The increase in common shares outstanding is primarily due to the conversion of redeemable Class A preferred stock and the exercise of Series B warrants[21] - Accumulated deficit decreased by $26.4 million, reflecting the net income reported for the six months ended June 30, 2023[21] - Accumulated other comprehensive income shifted from a gain to a loss, primarily due to reclassification adjustments related to debt extinguishment[21] Consolidated Statements of Cash Flows This statement summarizes the cash inflows and outflows from operating, investing, and financing activities for the six months ended June 30, 2023 and 2022 Consolidated Statements of Cash Flows Highlights (in thousands): | Activity | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | | Net cash (used in) provided by operating activities | $(8,299) | $6,246 | | Net cash provided by (used in) investing activities | $15,128 | $(2,185) | | Net cash used in financing activities | $(60,315) | $(7,764) | | Net decrease in cash and cash equivalents and restricted cash from continuing operations | $(53,452) | $(2,759) | - Operating activities shifted from providing $6.246 million in cash in 2022 to using $(8.299) million in 2023, primarily due to indemnity payments and management fees[24] - Investing activities provided $15.128 million in cash in 2023, a significant improvement from using $(2.185) million in 2022, mainly from distributions from limited liability investments and proceeds from fixed maturities[24] - Financing activities used $(60.315) million in cash in 2023, substantially higher than $(7.764) million in 2022, primarily due to the repurchase of subordinated debt[24] Notes to Consolidated Financial Statements These notes provide detailed explanations of the accounting policies, significant transactions, and financial instrument valuations underlying the consolidated financial statements NOTE 1 BUSINESS Kingsway Financial Services Inc. is a Delaware-incorporated holding company with operating subsidiaries primarily in the extended warranty and business services industries in the United States - Kingsway Financial Services Inc. is a holding company with operating subsidiaries in the extended warranty and business services industries[27] NOTE 2 BASIS OF PRESENTATION The unaudited consolidated interim financial statements are prepared in accordance with U.S. GAAP for interim information, relying on management estimates and assumptions. They should be read in conjunction with the 2022 Annual Report on Form 10-K - Interim financial statements are unaudited and prepared under U.S. GAAP, requiring management estimates and assumptions[28][31] - Critical accounting estimates include revenue recognition, investment valuations, impairment assessments, deferred income taxes, business combinations, intangible assets, goodwill, deferred contract costs, and fair value assumptions for debt and derivatives[32] NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Significant accounting policies remain largely unchanged from the 2022 Annual Report, with updates effective January 1, 2023, for Investments and Service Fee Receivables due to the adoption of ASU 2016-13, focusing on expected credit losses - No material changes to significant accounting policies except for updates to Investments and Service Fee Receivables[33][34] - New policy for Investments (Impairments) evaluates intent to sell or credit loss existence for available-for-sale fixed maturities; credit losses are recognized through an allowance[35][39] - Service Fee Receivables now recognize credit losses based on a forward-looking current expected credit losses model, considering historical experience, credit quality, and economic conditions[41] NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS Effective January 1, 2023, the Company adopted ASU 2016-13, replacing the incurred loss model with an expected loss model for credit losses on financial instruments, with no cumulative-effect adjustment to accumulated deficit. ASU 2023-02, regarding tax credit structures, is not expected to impact the financial statements - Adopted ASU 2016-13 (Financial Instruments-Credit Losses) on January 1, 2023, using a modified retrospective method, with no cumulative-effect adjustment to accumulated deficit[42][43] - ASU 2016-13 replaces the incurred loss model with an expected loss model for various receivables and financial instruments at amortized cost, and modifies impairment measurement for available-for-sale fixed maturities[42] - ASU 2023-02 (Investments Equity Method and Joint Ventures) is not expected to impact the consolidated financial statements[44] NOTE 5 ACQUISITIONS, DISPOSAL AND DISCONTINUED OPERATIONS Kingsway completed two acquisitions in late 2022 (CSuite Financial Partners, LLC and Secure Nursing Service, Inc.) to expand its Kingsway Search Xcelerator segment. The Company also disposed of Professional Warranty Service Corporation (PWSC) in July 2022 and classified its Leased Real Estate segment as discontinued operations due to strategic shifts and asset sales Business Combinations This section details the acquisitions made by the company to expand its Kingsway Search Xcelerator segment - Acquired 100% of CSuite Financial Partners, LLC on November 1, 2022, for approximately $8.5 million cash, plus potential contingent consideration up to $3.6 million[45][47] - Acquired substantially all assets of Secure Nursing Service, Inc. (SNS) on November 18, 2022, for $11.5 million cash[49] - Both CSuite and SNS acquisitions expand the Kingsway Search Xcelerator segment with recurring revenue and low capital intensity businesses[46][49] Disposal This section outlines the disposal of Professional Warranty Service Corporation (PWSC) and its financial impact - Sold Professional Warranty Service Corporation (PWSC) on July 29, 2022, which was an 80% majority-owned subsidiary[51] - The sale of PWSC did not represent a strategic shift for the Company and is not presented as a discontinued operation[53] PWSC Contribution to Extended Warranty Segment (in thousands): | Metric | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | | Service fee and commission revenue | $2,100 | $4,200 | | Pre-tax income (loss) | $400 | $(300) | | Pre-tax income (loss) attributable to controlling interest | $300 | $(200) | Discontinued Operations This section details the reclassification of the Leased Real Estate segment as discontinued operations due to strategic shifts and asset sales - The Leased Real Estate segment (CMC and VA Lafayette) was classified as discontinued operations due to a strategic shift and asset sales, representing over 20% of total assets[55][57] - CMC's real property was sold on December 29, 2022, for $44.5 million gross cash proceeds[58][59] - VA Lafayette, owning LA Real Property, was classified as held for sale at June 30, 2023, and December 31, 2022[61][62] Income from Discontinued Operations, Net of Taxes (in thousands): | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Rental revenue | $311 | $3,633 | $630 | $7,300 | | Total expenses | $201 | $2,834 | $413 | $4,993 | | Income from discontinued operations, net of taxes | $110 | $786 | $217 | $2,281 | Assets and Liabilities Held for Sale (Leased Real Estate, in thousands): | Category | June 30, 2023 | December 31, 2022 | | :------------------------------------ | :------------ | :---------------- | | Assets held for sale | $19,455 | $19,478 | | Liabilities held for sale | $16,324 | $16,585 | NOTE 6 INVESTMENTS The Company's investment portfolio primarily consists of fixed maturities, equity investments, and limited liability investments. Fixed maturities are classified as available-for-sale, with significant unrealized losses primarily due to non-credit related factors. Net investment income decreased for the three months but remained stable for the six months, while equity investments saw significant fair value gains Total Investments (in thousands): | Category | June 30, 2023 | December 31, 2022 | | :------------------------------------ | :------------ | :---------------- | | Total fixed maturities (at fair value) | $36,193 | $37,591 | | Equity investments (at fair value) | $2,935 | $153 | | Limited liability investments | $899 | $983 | | Limited liability investments, at fair value | $3,688 | $17,059 | | Total investments | $44,758 | $56,934 | - At June 30, 2023, fixed maturities had $2.390 million in gross unrealized losses, primarily due to non-credit related factors, with no intent to sell before recovery[67][72] Net Investment Income (in thousands): | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Gross investment income | $360 | $493 | $1,135 | $1,135 | | Investment expenses | $(30) | $(28) | $(67) | $(51) | | Net investment income | $330 | $465 | $1,068 | $1,084 | - Gain on change in fair value of equity investments was $1.707 million for the three months and $2.782 million for the six months ended June 30, 2023, compared to losses in the prior year, driven by the investment in Limbach Holdings, Inc[83] NOTE 7 GOODWILL Goodwill decreased slightly by $0.01 million to $45.488 million at June 30, 2023, due to a working capital true-up from the CSuite acquisition. No impairment charges were recorded for the periods presented Goodwill Activity (in thousands): | Segment | December 31, 2022 | Measurement Period Adjustment | June 30, 2023 | | :-------------------- | :---------------- | :---------------------------- | :------------ | | Extended Warranty | $31,153 | $0 | $31,153 | | Kingsway Search Xcelerator | $13,613 | $(10) | $13,603 | | Corporate | $732 | $0 | $732 | | Total | $45,498 | $(10) | $45,488 | - Goodwill is assessed for impairment annually as of November 30, or more frequently if circumstances indicate recoverability issues. No impairment charges were recorded for the three and six months ended June 30, 2023 and 2022[86] NOTE 8 INTANGIBLE ASSETS Net intangible assets decreased to $30.271 million at June 30, 2023, from $33.099 million at December 31, 2022, primarily due to amortization. Trade names, with indefinite useful lives, are not amortized and were assessed for impairment qualitatively and quantitatively, with no impairment recorded Intangible Assets (in thousands): | Category | June 30, 2023 Net Carrying Value | December 31, 2022 Net Carrying Value | | :------------------------------------ | :------------------------------- | :------------------------------- | | Customer relationships | $15,984 | $18,812 | | Trade names | $14,287 | $14,287 | | Total | $30,271 | $33,099 | - Amortization of intangible assets was $1.4 million for the three months and $2.8 million for the six months ended June 30, 2023[87] - Indefinite-lived intangible assets (trade names) are assessed for impairment annually; no impairment charges were recorded for the periods presented[88] NOTE 9 PROPERTY AND EQUIPMENT Net property and equipment decreased to $0.640 million at June 30, 2023, from $0.773 million at December 31, 2022. Depreciation expense was $0.1 million for both the three and six months ended June 30, 2023 Property and Equipment (in thousands): | Category | June 30, 2023 Carrying Value | December 31, 2022 Carrying Value | | :------------------------------------ | :----------------------------- | :----------------------------- | | Leasehold improvements | $235 | $279 | | Furniture and equipment | $48 | $56 | | Computer hardware | $357 | $438 | | Total | $640 | $773 | - Depreciation expense on property and equipment was $0.1 million for the three months ended June 30, 2023 and 2022, and $0.1 million and $0.2 million for the six months ended June 30, 2023 and 2022, respectively[91] NOTE 10 DERIVATIVES The Company holds an interest rate swap to manage variable interest rate exposure on its 2020 KWH Loan, recorded at fair value as an asset. Additionally, the Company entered into and subsequently exercised Trust Preferred Debt Repurchase Options (TruPs Options) in early 2023, which were derivative contracts measured at fair value, resulting in a $1.4 million loss on change in fair value for the six months ended June 30, 2023 - Interest rate swap: Notional amount of $7.7 million at June 30, 2023, with a fair value asset of $0.2 million. Recognized a loss of less than $0.1 million for the three months and $0.1 million for the six months ended June 30, 2023[94] - Trust Preferred Debt Repurchase Options (TruPs Options): Derivative contracts entered in Q3 2022, exercised in March 2023. Fair value was $19.0 million at December 31, 2022[104][105] - Recognized a loss on change in fair value of TruPs Options contracts of $1.4 million for the six months ended June 30, 2023[105] NOTE 11 DEBT Total debt decreased significantly from $102.092 million at December 31, 2022, to $42.045 million at June 30, 2023, primarily due to the repurchase of $75.5 million in Trust Preferred Debt (TruPs) for $56.5 million, resulting in a $31.6 million gain on extinguishment. The Company also has various bank loans (Ravix, SNS, KWH) with floating interest rates and associated covenants Debt Summary (in thousands): | Category | June 30, 2023 Carrying Value | December 31, 2022 Carrying Value | | :------------------------------------ | :----------------------------- | :----------------------------- | | Total bank loans | $29,501 | $34,281 | | Subordinated debt (at fair value) | $12,544 | $67,811 | | Total Debt | $42,045 | $102,092 | - Repurchased $75.5 million of TruPs principal and $23.0 million of deferred interest payable for $56.5 million in March 2023, recognizing a $31.6 million gain on extinguishment of debt[126] - Bank loans include 2021 Ravix Loan (8.75% interest), 2022 Ravix Loan (9.00% interest), SNS Loan (8.75% interest), and 2020 KWH Loan (8.01% interest), all with various covenants[109][110][115][119] - The $55.3 million decrease in subordinated debt is primarily due to the $56.1 million repurchase of TruPs, partially offset by a $1.1 million increase in fair value of the remaining TruPs[129] NOTE 12 LEASES The Company has operating leases for office space, with total lease liabilities of $1.260 million at June 30, 2023. Lease costs, including fixed and variable payments, are expensed as incurred Annual Maturities of Lease Liabilities (in thousands): | Year | Lease Commitments | | :--- | :---------------- | | 2023 | $233 | | 2024 | $442 | | 2025 | $283 | | 2026 | $220 | | 2027 | $162 | | 2028 and thereafter | $79 | | Total undiscounted lease payments | $1,419 | | Imputed interest | $159 | | Total lease liabilities | $1,260 | - Weighted-average remaining lease term for operating leases was 3.81 years, with a weighted average discount rate of 5.94% at June 30, 2023[135] NOTE 13 REVENUE FROM CONTRACTS WITH CUSTOMERS Revenue from contracts with customers, primarily from Extended Warranty and Kingsway Search Xcelerator segments, increased to $26.197 million for the three months and $52.586 million for the six months ended June 30, 2023. Deferred service fees increased to $82.833 million, with approximately 50.5% expected to be recognized within one year Service Fee and Commission Revenue by Type (in thousands): | Revenue Type | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Vehicle service agreement fees and GAP commissions | $15,034 | $14,832 | $29,869 | $28,135 | | Maintenance support service fees | $930 | $1,394 | $1,884 | $3,192 | | Warranty product commissions | $1,079 | $1,096 | $1,961 | $2,228 | | Homebuilder warranty service fees | $0 | $1,911 | $0 | $3,727 | | Homebuilder warranty commissions | $0 | $211 | $0 | $448 | | Business services consulting fees | $9,154 | $4,146 | $18,872 | $8,316 | | Total service fee and commission revenue | $26,197 | $23,590 | $52,586 | $46,046 | - Business services consulting fees saw significant growth, increasing from $4.146 million to $9.154 million for the three months and $8.316 million to $18.872 million for the six months ended June 30, 2023[137] Deferred Service Fees (in thousands): | Metric | June 30, 2023 | | :------------------------------------ | :------------ | | Balance, December 31, 2022 | $82,713 | | Deferral of revenue | $29,819 | | Recognition of deferred service fees | $(29,699) | | Balance, June 30, 2023 | $82,833 | - Deferred contract costs increased to $13.792 million at June 30, 2023, from $13.257 million at December 31, 2022, with additions exceeding amortization[154] NOTE 14 INCOME TAXES The Company reported income tax expense of $0.213 million for the three months and $0.912 million for the six months ended June 30, 2023, primarily due to state tax expense. A full valuation allowance is maintained for gross deferred tax assets due to uncertainty of future taxable income Income Tax Expense (Benefit) (in thousands): | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Income tax (benefit) expense at U.S. statutory income tax rate | $(338) | $(666) | $5,643 | $(1,594) | | Valuation allowance | $240 | $176 | $(5,664) | $469 | | State income tax | $121 | $150 | $610 | $195 | | Income tax expense (benefit) | $213 | $(19) | $912 | $(441) | - The Company maintains a full valuation allowance on its net deferred tax asset due to uncertainty regarding the generation of future taxable income to utilize prior operating losses[155] - Net deferred income tax liabilities were $4.3 million at June 30, 2023, primarily related to indefinite-lived intangible assets and state income tax[157][159] NOTE 15 (LOSS) EARNINGS PER SHARE Basic and diluted earnings per share from continuing operations were $(0.06) for the three months and $1.06 and $0.97, respectively, for the six months ended June 30, 2023. Potentially dilutive securities were excluded from loss periods as their inclusion would be anti-dilutive Basic and Diluted (Loss) Earnings Per Share (attributable to common shareholders): | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Basic EPS - Continuing operations | $(0.06) | $(0.15) | $1.06 | $(0.32) | | Diluted EPS - Continuing operations | $(0.06) | $(0.15) | $0.97 | $(0.32) | | Basic EPS - Net (loss) income | $(0.06) | $(0.12) | $1.07 | $(0.24) | | Diluted EPS - Net (loss) income | $(0.06) | $(0.12) | $0.98 | $(0.24) | Weighted-Average Shares Outstanding (in '000s): | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Basic | 25,295 | 22,883 | 24,681 | 22,883 | | Diluted | 25,295 | 22,883 | 26,850 | 22,883 | - Potentially dilutive securities, including unvested restricted stock awards and warrants, were excluded from diluted EPS calculations in loss periods or when anti-dilutive[160][161] NOTE 16 STOCK-BASED COMPENSATION The Company granted restricted stock awards (RSAs) under its 2013 and 2020 Equity Incentive Plans, with total unamortized compensation expense of $2.9 million at June 30, 2023. Additionally, Ravix and SNS granted restricted common unit awards (RUAs) to officers, with vesting based on service and performance conditions - Total unamortized compensation expense for the Company's Restricted Stock Awards was $2.9 million at June 30, 2023[163][164] - Ravix LLC granted 199,000 restricted Class B common unit awards (2021 Ravix RUA) vesting based on service and Ravix/CSuite IRR, with 80,944 unvested shares at June 30, 2023[172][175][176] - Pegasus LLC granted 75,000 restricted Class B common unit awards (SNS RUA) vesting based on service and SNS IRR, with 50,000 unvested shares at June 30, 2023[178][180] NOTE 17 REDEEMABLE CLASS A PREFERRED STOCK All 149,733 outstanding Class A Preferred Shares were converted into 935,831 common shares during the six months ended June 30, 2023, following the Company's notice of redemption - Zero Class A Preferred Shares outstanding at June 30, 2023, down from 149,733 at December 31, 2022[184] - During the six months ended June 30, 2023, 149,733 Preferred Shares were converted into 935,831 common shares at a conversion price of $4.00 per common share[184] NOTE 18 SHAREHOLDERS' EQUITY Shareholders' equity was impacted by the conversion of preferred stock to common stock, increasing additional paid-in capital by $6.1 million. The Company also initiated a $10.0 million security repurchase program, repurchasing 564,970 shares of common stock and warrants for $2.1 million during the three months ended June 30, 2023 - Conversion of 149,733 Preferred Shares resulted in 935,831 common shares and a $6.1 million reclassification to additional paid-in capital[185] - Board approved a $10.0 million security repurchase program through March 22, 2024[186] - Repurchased 564,970 shares of common stock and warrants for approximately $2.1 million during the three months ended June 30, 2023[186] - Warrants to purchase 1,311,941 common shares were exercised during the six months ended June 30, 2023, generating $6.6 million in cash proceeds[187] NOTE 19 ACCUMULATED OTHER COMPREHENSIVE INCOME Accumulated other comprehensive income (loss) attributable to common shareholders shifted from a gain of $26.605 million at January 1, 2023, to a loss of $(1.258) million at June 30, 2023. This change was primarily driven by a $27.177 million reclassification adjustment to gain on extinguishment of debt related to repurchased Trust Preferred Debt (TruPs) Accumulated Other Comprehensive Income (Loss) (in thousands): | Component | June 30, 2023 | December 31, 2022 | | :------------------------------------ | :------------ | :---------------- | | Unrealized Losses on Available-for-Sale Investments | $(2,326) | $(2,464) | | Foreign Currency Translation Adjustments | $(3,286) | $(3,286) | | Change in Fair Value of Debt Attributable to Instrument-Specific Credit Risk | $4,354 | $32,355 | | Total Accumulated Other Comprehensive Loss | $(1,258) | $26,605 | - A reclassification adjustment of $27.177 million from accumulated other comprehensive income to gain on extinguishment of debt occurred due to the repurchase of TruPs[193][194] NOTE 20 SEGMENTED INFORMATION Kingsway operates through two reportable segments: Extended Warranty and Kingsway Search Xcelerator. The Leased Real Estate segment was reclassified as discontinued operations. Extended Warranty revenue decreased due to the PWSC disposal and mild weather impacting Trinity, while Kingsway Search Xcelerator revenue significantly increased due to recent acquisitions - Kingsway operates two reportable segments: Extended Warranty and Kingsway Search Xcelerator. The Leased Real Estate segment was reclassified as discontinued operations[195][196] Revenues by Reportable Segment (in thousands): | Segment | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Extended Warranty | $17,043 | $19,444 | $33,714 | $37,730 | | Kingsway Search Xcelerator | $9,154 | $4,146 | $18,872 | $8,316 | | Total revenues | $26,197 | $23,590 | $52,586 | $46,046 | Segment Operating Income (in thousands): | Segment | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Extended Warranty | $1,392 | $2,936 | $2,824 | $4,659 | | Kingsway Search Xcelerator | $1,616 | $893 | $3,193 | $1,699 | | Total segment operating income | $3,008 | $3,829 | $6,017 | $6,358 | NOTE 21 FAIR VALUE OF FINANCIAL INSTRUMENTS The Company categorizes financial instruments measured at fair value using a three-level hierarchy. Fixed maturities and interest rate swaps are Level 2, while certain limited liability investments, trust preferred debt repurchase options, and contingent consideration are Level 3, requiring significant unobservable inputs. The fair value of Net Lease's investments, previously measured using NAV, is now zero due to asset sales - Fair value hierarchy: Level 1 (quoted prices in active markets), Level 2 (observable inputs), Level 3 (unobservable inputs)[213] - Fixed maturities are classified as Level 2, valued using market approach with inputs like trades, quoted prices in inactive markets, and credit spreads[212][219] - Limited liability investments, at fair value, contingent consideration, and derivative contracts (TruPs options) are categorized as Level 3, utilizing valuation multiples, discount rates, risk-free rates, and expected volatility as unobservable inputs[220][222][223][230] Assets and Liabilities Measured at Fair Value (in thousands): | Category | June 30, 2023 Total Fair Value | December 31, 2022 Total Fair Value | | :------------------------------------ | :----------------------------- | :----------------------------- | | Total Assets | $43,020 | $74,163 | | Total Liabilities | $15,827 | $71,029 | NOTE 22 RELATED PARTIES The Company's CEO and certain family members hold equity interests in Argo Holdings, managed by Argo Management Group, LLC, a Company subsidiary. Equity holders are required to fund pro rata shares of Capital Calls, though none occurred in the reported periods - John T. Fitzgerald, CEO, and his immediate family members own equity interests in Argo Holdings, managed by Argo Management Group, LLC, a Company subsidiary[235] - Equity holders in Argo Holdings are required to fund pro rata shares of Capital Calls, but no Capital Calls were made during the six months ended June 30, 2023, or the year ended December 31, 2022[235] NOTE 23 COMMITMENTS AND CONTINGENCIES The Company faces legal proceedings, including an indemnification obligation to Aegis Security Insurance Company for customs bond losses, with a $0.1 million reimbursement payment made in Q2 2023. It also settled a $2.5 million guarantee related to the Mendota sale. Restricted cash of $9.6 million is held for various purposes, including deposits by subsidiaries and state regulatory authorities - Made a $0.1 million reimbursement payment to Aegis Security Insurance Company in Q2 2023 for customs bond losses, with potential exposure up to $4.8 million[236] - Satisfied a $2.5 million payment obligation related to open claims from the Mendota sale by releasing $2.0 million from escrow in Q1 2023, with no remaining exposure[239] - Restricted cash totaled $9.6 million at June 30, 2023, including $8.4 million held as deposits by subsidiaries and $0.5 million on deposit with state regulatory authorities[241][243] NOTE 24 SUBSEQUENT EVENT Between July 1 and August 7, 2023, 450,619 of the Company's outstanding warrants were exercised, generating $2.3 million. As of August 7, 2023, 2,143,506 warrants remained outstanding, expiring on September 15, 2023 - 450,619 warrants were exercised between July 1 and August 7, 2023, generating $2.3 million[242] - As of August 7, 2023, 2,143,506 warrants with a $5.00 strike price remained outstanding, expiring on September 15, 2023[242] ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section provides management's perspective on Kingsway Financial Services Inc.'s financial condition and results of operations for the three and six months ended June 30, 2023. It covers segment performance, investment activities, debt management, liquidity, and capital resources, highlighting the impact of acquisitions, disposals, and debt repurchases on the Company's financial results FORWARD-LOOKING STATEMENTS This section highlights that the report contains forward-looking statements subject to risks and uncertainties, and the company disclaims any obligation to update them - The discussion includes forward-looking statements subject to risks and uncertainties that could cause actual results to differ materially[244] - The Company disclaims any obligation to update or revise forward-looking statements unless required by applicable securities law[244] OVERVIEW Kingsway is a Delaware holding company operating through two reportable segments: Extended Warranty and Kingsway Search Xcelerator, with its Leased Real Estate segment reclassified as discontinued operations - Kingsway is a Delaware holding company with operating subsidiaries in extended warranty and business services, operating through two reportable segments: Extended Warranty and Kingsway Search Xcelerator[245] - The Extended Warranty segment includes IWS, Geminus, PWI, PWSC (disposed July 2022), and Trinity, offering vehicle protection, home warranties, and HVAC/generator warranty products[247][248][249][250][252][253] - The Kingsway Search Xcelerator segment includes CSuite, Ravix, and SNS, providing financial executive services, HR consulting, and healthcare staffing[255][256] - The Leased Real Estate segment (CMC and VA Lafayette) was classified as discontinued operations, with CMC's property sold in December 2022 and VA Lafayette held for sale[246][251] NON-U.S. GAAP FINANCIAL MEASURE This section defines segment operating income as a non-U.S. GAAP financial measure and identifies its nearest comparable U.S. GAAP measure - Segment operating income is presented as a non-U.S. GAAP financial measure, representing pretax profitability of segments by subtracting direct segment expenses from direct segment revenues[257][258] - The nearest comparable U.S. GAAP measure is (loss) income from continuing operations before income tax expense (benefit)[258] SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ESTIMATES This section states that the preparation of financial statements involves management estimates and assumptions, with no material changes since the 2022 Annual Report - Preparation of financial statements requires management to make estimates and assumptions affecting reported amounts[259] - No material changes to significant accounting policies and critical estimates since December 31, 2022, as reported in the 2022 Annual Report[261] RESULTS OF CONTINUING OPERATIONS The Company reported a net income of $26.172 million for the six months ended June 30, 2023, a significant improvement from a loss in the prior year, primarily driven by a $31.6 million gain on extinguishment of debt. Segment operating income decreased overall, with Extended Warranty declining due to the PWSC disposal and increased claims, while Kingsway Search Xcelerator grew significantly from recent acquisitions Segment Operating Income, (Loss) Income from Continuing Operations and Net (Loss) Income This section provides a summary of segment operating income, income from continuing operations, and net income (loss) for the reported periods Segment Operating Income and Net (Loss) Income (in thousands): | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :------------------------------------------------ | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Total segment operating income | $3,008 | $3,829 | $6,017 | $6,358 | | (Loss) income from continuing operations before income tax expense (benefit) | $(1,564) | $(3,170) | $26,867 | $(7,591) | | Net (loss) income | $(1,667) | $(2,365) | $26,172 | $(4,869) | - Total segment operating income decreased by $0.8 million for the three months and $0.3 million for the six months ended June 30, 2023, primarily due to the disposal of PWSC and decreased operating income at other Extended Warranty subsidiaries, partially offset by increased operating income from Kingsway Search Xcelerator[263] - Net income for the six months ended June 30, 2023, was $26.172 million, a significant improvement from a loss of $(4.869) million in the prior year, largely driven by a $31.6 million gain on extinguishment of debt[262][267] Extended Warranty This section details the performance of the Extended Warranty segment, noting revenue and operating income declines due to the PWSC disposal and increased claims - Extended Warranty service fee and commission revenue decreased by 12.4% to $17.0 million for the three months and to $33.7 million for the six months ended June 30, 2023[269] - Revenue decline was primarily due to the $2.1 million decrease from PWSC disposal and a $0.5 million decrease at Trinity due to mild weather and long lead times[272] - Operating income decreased to $1.4 million for the three months and $2.8 million for the six months ended June 30, 2023, mainly due to increased claims paid at auto Extended Warranty companies from inflationary pressures on parts and labor[270][272][273] Kingsway Search Xcelerator This section highlights the significant growth in revenue and operating income for the Kingsway Search Xcelerator segment, driven by recent acquisitions - Kingsway Search Xcelerator revenue increased to $9.2 million for the three months and $18.9 million for the six months ended June 30, 2023[274] - Operating income increased to $1.6 million for the three months and $3.2 million for the six months ended June 30, 2023[274] - The increases in revenue and operating income are primarily due to the inclusion of CSuite and SNS following their acquisitions in November 2022[274] Net Investment Income This section reports on the company's net investment income, noting a decrease in Q2 2023 but stable year-to-date performance - Net investment income was $0.3 million in Q2 2023, down from $0.5 million in Q2 2022, primarily due to decreased income from real estate investments[275] - Year-to-date net investment income remained stable at $1.1 million for both 2023 and 2022[275] Net Realized Gains This section details the net realized gains, primarily from Argo Holdings and sales of limited liability investments - Net realized gains were $0.1 million in Q2 2023 and $0.3 million year-to-date, primarily from Argo Holdings and sales of limited liability investments[276] Gain (Loss) on Change in Fair Value of Equity Investments This section reports a significant gain on equity investments, primarily driven by the company's investment in Limbach Holdings, Inc - Recorded a gain of $1.7 million in Q2 2023 and $2.8 million year-to-date on equity investments, a significant improvement from losses in the prior year[277] - The gain is attributed to the Company's investment in Limbach Holdings, Inc., following an increase in its common stock price and a cashless exercise of warrants[277] Gain (Loss) on Change in Fair Value of Limited Liability Investments, at Fair Value This section discusses the loss reported for limited liability investments at fair value, influenced by Net Lease and Argo Holdings, with Net Lease's investment now at zero - Reported a loss of $0.1 million year-to-date for limited liability investments at fair value, compared to a gain of $0.2 million in the prior year[278] - The year-to-date loss reflects a $0.5 million decrease in fair value related to Net Lease, partially offset by a $0.4 million increase related to Argo Holdings[278] - The Company's investment in Net Lease is now zero following the sale of its final investment property in Q2 2023[278] Loss on Change in Fair Value of Derivative Asset Option Contracts This section reports a loss related to the change in fair value of derivative asset option contracts, specifically the exercised trust preferred debt repurchase options - A loss of $1.4 million was recognized for the six months ended June 30, 2023, related to the change in fair value of derivative asset option contracts[279] - This loss is associated with the three trust preferred debt repurchase option agreements that the Company entered into and exercised during the first quarter of 2023[279] Interest Expense This section details the company's interest expense, noting a decrease in Q2 2023 due to debt repurchase but an increase year-to-date from higher LIBOR rates and new bank loans - Interest expense decreased to $1.1 million in Q2 2023 from $1.7 million in Q2 2022, but increased to $4.1 million year-to-date from $3.1 million in the prior year[281] - The Q2 decrease is due to the repurchase of subordinated debt, while the year-to-date increase is from higher LIBOR rates on remaining subordinated debt and new bank loans (SNS, 2022 Ravix)[287] Other Revenue and Expenses not Allocated to Segments, Net This section discusses the net increase in unallocated expenses, primarily due to management fees paid to managers of Net Lease and Flower - Net expense increased to $3.8 million in Q2 2023 from $3.2 million in Q2 2022, and to $6.4 million year-to-date from $6.2 million in the prior year[282] - The Q2 increase is mainly due to a $1.5 million management fee paid to the manager of Net Lease[264][283] - The year-to-date increase is attributable to management fees paid to managers of Flower and Net Lease, partially offset by decreased stock-based compensation expense[284] Loss on Change in Fair Value of Debt This section reports on the loss from changes in the fair value of debt, influenced by market rates and credit spread assumptions - Loss on change in fair value of debt decreased to $0.3 million in Q2 2023 from $1.3 million in Q2 2022, and to less than $0.1 million year-to-date from $3.2 million in the prior year[285] - The year-to-date change reflects a $0.3 million gain on repurchased TruPs debt and a $0.3 million loss on the remaining TruPs debt[285] - Changes in fair value are primarily influenced by changes in LIBOR and risk-free rates, and credit spread assumptions[286] Gain on Extinguishment of Debt This section details the significant gain recognized from the extinguishment of debt, resulting from the repurchase of Trust Preferred Debt (TruPs) - Recognized a $31.6 million gain on extinguishment of debt for the six months ended June 30, 2023[289] - This gain resulted from the repurchase of $75.5 million of Trust Preferred Debt (TruPs) and the removal of related fair value, options, deferred interest, and accumulated other comprehensive income from the balance sheet[289] Income Tax Expense (Benefit) This section reports on the company's income tax expense, primarily due to state taxes, and contrasts it with a prior year benefit from valuation allowance release - Income tax expense was $0.2 million in Q2 2023 and $0.9 million year-to-date, primarily due to state tax expense[290] - In Q2 2022, the Company reported an income tax benefit, mainly from the release of a valuation allowance on indefinite-life business interest expense carryforwards[290] INVESTMENTS The Company's investment portfolio, including cash and restricted cash, totaled $68.5 million at June 30, 2023, a decrease from $134.2 million at December 31, 2022. Fixed maturities constitute the largest portion, with unrealized losses primarily due to non-credit factors. The Company recorded impairment losses related to other investments and limited liability investments at fair value Portfolio Composition This section outlines the composition and carrying value of the company's investment portfolio, cash, and restricted cash Carrying Value of Investments, Cash, and Restricted Cash (in thousands): | Type of Investment | June 30, 2023 | % of Total | December 31, 2022 | % of Total | | :------------------------------------ | :------------ | :--------- | :---------------- | :--------- | | Total fixed maturities | $36,193 | 52.8% | $37,591 | 28.1% | | Equity investments - common stock | $2,935 | 4.3% | $153 | 0.1% | | Limited liability investments, at fair value | $3,688 | 5.4% | $17,059 | 12.7% | | Total investments | $44,758 | 65.3% | $56,934 | 42.4% | | Cash and cash equivalents | $14,162 | 20.7% | $64,168 | 47.9% | | Restricted cash | $9,618 | 14.0% | $13,064 | 9.7% | | Total | $68,538 | 100.0% | $134,166 | 100.0% | - Total investments, cash, and restricted cash decreased by $65.6 million from December 31, 2022, to June 30, 2023[293] Investment Impairment This section discusses the company's policy and recorded impairment losses for investments, particularly fixed maturities and other investments - Effective January 1, 2023, the Company adopted ASU 2016-13, requiring credit losses on fixed maturities to be reported in net (loss) income if a credit loss exists and cash flows are insufficient to cover amortized cost[295] - Recorded an impairment loss of $0.1 million related to other investments for the three and six months ended June 30, 2023[296] - No impairment losses were recorded for available-for-sale fixed maturity investments for the three and six months ended June 30, 2023[296] - Gross unrealized losses for fixed maturities were $2.4 million at June 30, 2023, with no losses attributable to non-investment grade fixed maturities[300] DEBT The Company's debt portfolio includes various bank loans and subordinated debt. A significant event was the repurchase of $75.5 million of Trust Preferred Debt (TruPs) in March 2023, resulting in a $31.6 million gain on extinguishment and a substantial reduction in total subordinated debt. Bank loans carry floating interest rates and specific covenants Bank Loans This section details the company's bank loans, including interest rates, maturities, and associated covenants - The 2020 KWH Loan has an annual interest rate of 8.01% at June 30, 2023, and matures on December 1, 2025. A second amendment provides for an additional delayed draw term loan of up to $10.0 million[302][304] - The 2021 Ravix Loan (8.75% interest) and 2022 Ravix Loan (9.00% interest) are secured by assets of Ravix and CSuite, with the 2022 Ravix Loan maturing on November 16, 2028[305][306] - The SNS Loan (8.75% interest) matures on November 18, 2028, and is secured by SNS assets. All bank loans contain various covenants restricting additional indebtedness, liens, and distributions[308][309] Subordinated Debt This section focuses on the company's subordinated debt, highlighting the significant repurchase of Trust Preferred Debt (TruPs) and its impact on debt levels and fair value - In March 2023, the Company repurchased $75.5 million of Trust Preferred Debt (TruPs) for $56.5 million, resulting in a $31.6 million gain on extinguishment[319] - The repurchase included a credit for $2.3 million previously paid for repurchase options[319] - At June 30, 2023, $15.0 million of principal remained outstanding related to one TruPs instrument[319] - The fair value of subordinated debt increased by $0.8 million between December 31, 2022, and June 30, 2023, due to changes in market observable swap rates, credit spread assumptions, and the passage of time[323][326] RECENTLY ISSUED ACCOUNTING STANDARDS This section refers to Note 4 for details on recently issued accounting standards applicable to the Company's financial statements - Refer to Note 4 for discussion of recently issued accounting standards applicable to the Company's financial statements[328] LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity is primarily met by operations, capital raising, disposals, and investment income. Net cash used in operating activities from continuing operations was $8.6 million for the six months ended June 30, 2023, while investing activities provided $15.1 million. Financing activities used $60.0 million, largely due to subordinated debt repurchases. Holding company liquidity significantly decreased due to these repurchases, but future warrant exercises and available delayed draw term loans could provide additional funds Cash Flows This section summarizes the company's cash flows from operating, investing, and financing activities for continuing operations - Net cash used in operating activities from continuing operations was $8.6 million for the six months ended June 30, 2023, primarily due to management fees and an indemnity payment[332] - Net cash provided by investing activities from continuing operations was $15.1 million, mainly from distributions from limited liability investments and fixed maturity sales[333] - Net cash used in financing activities from continuing operations was $60.0 million, primarily due to the $56.5 million repurchase of TruPs and principal payments on bank loans[336] Holding Company Liquidity This section discusses the holding company's liquidity position, noting a significant decrease due to debt repurchases and potential future funding sources - Holding company liquidity was $5.7 million at June 30, 2023, a significant decrease from $48.9 million at December 31, 2022, primarily due to the repurchase of trust preferred debt[344][345] - The Company is entitled to receive $3.3 million of 2022 excess cash flow from KWH in 2023[338] - Potential future liquidity sources include $10.7 million from outstanding warrant exercises and an additional $10.0 million available from the KWH Delayed Draw Term Loan[346] - Management expects existing cash, investments, and anticipated cash flows to be sufficient for working capital and operating expenses for the next twelve months[347] REGULATORY CAPITAL This section outlines the regulatory capital requirements for Kingsway Reinsurance Corporation and its operational funding needs - Kingsway Reinsurance Corporation (Kingsway Re) is required to maintain minimum statutory capital of $125,000 by the Barbados regulator[349] - Kingsway Re operates near the regulatory minimum and requires periodic capital contributions to fund approximately $0.1 million in annual operating expenses[349] ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a smaller reporting company, Kingsway Financial Services Inc. is not required to provide quantitative and qualitative disclosures about market risk - The Company is a smaller reporting company and is not required to make disclosures under this Item[350] ITEM 4. CONTROLS AND PROCEDURES Management, with CEO and CFO participation, concluded that the Company's disclosure controls and procedures were not effective as of June 30, 2023, due to an unremediated material weakness related to accounting for complex and nonrecurring transactions, specifically ASU 2014-09. Despite this, management believes the financial statements fairly present the Company's financial condition. A remediation plan is expected to be implemented in 2023 Evaluation of Disclosure Controls and Procedures This section reports on the evaluation of the company's disclosure controls and procedures, concluding they were not effective due to a material weakness - Management concluded that disclosure controls and procedures were not effective as of June 30, 2023[353] - Ineffectiveness is due to an unremediated material weakness in internal control over financial reporting related to accounting for and disclosure of certain complex and nonrecurring transactions, specifically the adoption and application of ASU 2014-09[353][355] Material Weaknesses in Internal Control over Financial Reporting This section defines a material weakness and states management's belief that, despite the weakness, the financial statements are fairly presented - A material weakness is defined as a reasonable possibility that a material misstatement of financial statements will not be prevented or detected timely[354] - Despite the material weakness, management believes the unaudited consolidated financial statements for the three and six months ended June 30, 2023, fairly present the Company's financial condition, results of operations, and cash flows[356] [Remediation Process](index=94&t